FASB/IASB Lease Accounting Project Discussion Paper Summary EXECUTIVE OVERVIEW The positions where both the IASB and FASB agree are: • Lessees will have to estimate the lease term and payments to be capitalized (meaning renewal rents, all types of contingent rents, purchase options and residual guarantees). • Lessees will have to adjust estimates whenever financial results are published • Lessees must account for the capitalized lease obligation as a loan with imputed interest expense. • Lessees must account for the capitalized lease asset as though they own it, depreciating it, most likely straight line The FASB and IASB are split on: • The need for lease classification • Lessee P&L Timetable: The final target for the new lessee accounting rule is 2011 Commentary: The tone of the IASB is to move quickly on lessee changes while the FASB ponders how to resolve differences in views. The new project plan timetable as best I can determine is as follows: Date March 2009 July 2009 September 2009 October – February 2010 April 2010 August 2010 October 2010 2011 2011 Project milestone Ballot and publish the DP Comment letter deadline Comment letter analysis to the Board Board discussions on ED Ballot and publish ED Comment letter deadline Comment letter analysis to the Board Re-deliberations Ballot and publish standard
Summary of Decisions and Preliminary Views Scope and Overall Approach The project will initially focus on the accounting for lease arrangements within the scope of existing lease accounting literature. The scope of the project will include arrangements that are leases in form but in substance are an acquisition of the leased asset. They decided not to exclude leases that are financings (rights are ownership rights). They do not plan to give any threshold for what might constitute immaterial leases. They do not plan to exclude short term leases or leases of “non-core” assets. The IASB decided to remove the existing requirement to classify a lease as a finance
lease (in-substance purchase) or an operating lease. Thus, the same overall approach would apply for all leases. The FASB discussed whether there should be criteria to distinguish between leases that are an in-substance purchases and leases that are a right to use an asset, and decided that the classification should potentially remain for lessor accounting (sales-type leases) subsequent measurement and presentation depending on feedback to the Discussion Paper from financial statement users and preparers. The Boards also decided on an overall approach that would apply the existing finance lease model, adapted where necessary, to all leases – meaning those leases that were capital leases and those that were operating leases under current GAAP. All material leases will be capitalized. The concepts behind the approach are: • • • a lease contract gives the lessee the right to use an asset and obligates the lessee to pay rent for the term, the rights to use the asset are assets and the obligations to pay rents are liabilities that must be capitalized, to account for the whole lease contract rather than its components (like rent, purchase options, renewal options, contingent rents, etc).
The Boards decided to defer the development of a new accounting model for lessors, but the Boards decided to include a high-level discussion of lessor accounting issues in the Discussion Paper. This decision does not change the scope of the project. Options to Extend or Terminate a Lease The Boards decided that the lessee should not recognize options to extend or terminate a lease or options to purchase the leased asset as separate assets. Instead, the assets and liabilities recognized by the lessee should be based upon the estimated lease term and the estimated payments (rent, renewals and purchase options). The Boards decided that the determination of the lease term should be a recognition decision. For example, for a 10-year lease with an option to renew for 5 years, the lessee must determine if it is recognizing a 10-year lease or a 15-year lease, and then the lessee would recognize a right-to-use asset and obligation to pay rentals at the present value of the expected lease payments over that term. For leases with renewal, termination, and/or purchase options, the lessee would make a determination of the most likely lease term based on its own assessment of all contractual, non-contractual, and business factors. Contingent Rentals and Residual Guarantees The Boards decided to develop a new approach for contingent lease payments and residual guarantees. They decided that the lessee is obligated to pay contingent rents and residual guarantees as part of the contract – the issue is how to measure the amounts. The FASB decided that a lessee would measure contingent rentals and any residual value guarantees based on the lessee’s best estimate of the expected lease payments over the term of the lease. A lessee would determine its best estimate by considering the range of possible outcomes and the likelihood of each, but the lessee is not required to probability-
weight the various possible outcomes in determining the expected lease payments. However, if lease rentals are contingent on changes in an index or rate, such as the consumer price index or the prime interest rate, the lessee would measure the contingent rentals using the index or rate existing at the inception of the lease in its initial determination of the best estimate of expected lease payments The IASB decided that a lessee would measure contingent rentals and any residual value guarantees based on an expected outcome (probability-weighted) calculation of the expected lease payments over the term of the lease. Initial Measurement The Boards decided that a lessee should initially measure both its right-of-use asset and its lease obligation at their present value of the expected lease payments and that a lessee should discount the estimated lease payments using the lessee’s incremental borrowing rate for secured borrowings. Subsequent Measurement The Boards decided that a lessee should amortize/depreciate the right-of-use asset systematically over the shorter of the lease term and the economic life of the leased asset, but for leases of items in which it is expected that the lessee will obtain title at the end of the lease term (but they don’t tell you how to determine whether the lessee will obtain title at the end of the lease), the amortization period would be the economic life of the leased item Amortization would be based on the pattern of consumption of economic benefits embodied in the right-of-use asset. The lessee should apportion the lease payment between a finance charge and a reduction of the outstanding liability, with interest expense and amortization/depreciation presented on the income statement. However, some board members of the FASB believes that there were differences between leases that are in-substance purchases and leases that only convey a right to use that may merit differences in the subsequent measurement or presentation. Accordingly, the FASB instructed the staff to include questions for financial statement users in the Discussion Paper to assess whether users believe that leases that are in-substance purchases should be measured or presented differently from leases that only convey a right to use. Re-measurements The Boards decided that a lessee would be required to reassess the lease term and its lease obligation using its current assumptions at each reporting date. The Boards decided that a lessee should subsequently measure its lease obligation at the present value of its current estimate of expected lease payments over the revised lease term. The FASB decided to discount the expected lease payment at the effective interest rate determined at lease inception. The IASB decided to discount the expected lease payment at the current interest rate. The IASB did not reach a view on whether the interest rate should be revised at each reporting date or only when there is a change in estimated lease payments.
The FASB decided that a lessee would recognize changes in the lease obligation through a corresponding adjustment to the carrying value of the right-of-use asset to the extent that the change arises from updated expectations about the lease term (for example, a revised assessment of the likelihood that the entity will exercise a renewal option) and through profit or loss to the extent that the change arises from updated expectations about the measurement of contingent rentals or residual value guarantees. The IASB decided that a lessee would recognize all changes in the lease obligation through a corresponding adjustment to the carrying value of the right-of-use asset.
Presentation The Boards decided that leases should be presented separately from, but adjacent to, owned assets on the statement of financial position. Some FASB Board members believe that leases should be presented as either in-substance purchases or rights to use assets. The IASB decided that all leases should be presented based on the nature of the underlying asset. The FASB decided that the obligation to pay rentals should be presented separately from other financial liabilities on the statement of financial position. The IASB decided that the obligation to pay rentals should not be required to be presented separately from other financial liabilities on the statement of financial position. The Boards think that the balance sheet treatment should drive the income statement presentation, thus they decided that no rent expense should appear in the income statement. Instead interest expense and depreciation/amortization are the lease expense, although some FASB members think that rent expense may be the appropriate expense for some leases (right-of-use leases). The Boards have not decided on the presentation in the cash flow statement, however if the balance sheet treatment drives the cash flow statement presentation it is likely that a lease will be considered a capital expenditure and a financing for cash flow purposes. Lessor Accounting The Discussion Paper included a high level discussion of lessor accounting. It includes 2 approaches as possible models. One is a direct finance-like model where the lessor derecognizes the leased asset and record a receivable and residual asset and unearned income. The other approach is to leave the leased asset on the books but record a receivable being the lessor’s right to receive payments and record an offsetting liability representing the lessor’s obligation to allow the lessee to use the asset. No clear details of revenue recognition are provided.
Some Board members think that sales-type lease accounting is appropriate for certain leases, but many don’t think so.
Regarding sublessor accounting, the boards discussed but did not reach a preliminary view on three possible ways of addressing how an intermediate lessor should account for the sublease. The boards could: • provide additional guidance on how to apply the existing lessor accounting standards to subleases, • exclude the head lease from the scope of the new standard, • develop a lessor right-of-use model for subleases only. There was no mention of leveraged lease accounting or adopting IAS 17 for lesser accounting. Items not Covered The Discussion paper did not include any decisions on timing of initial recognition, sale leasebacks, initial direct costs, leases with service arrangements or disclosures. Impact The new developments in the Lease Accounting Project are a negative for the industry as: • “Fixing” the liability side of the balance sheet is a popular issue and will be accomplished by the proposed standard but the asset, P&L and cash flow treatment will not clearly represent the economic effects of a right-of -use lease to the lessee. Leases with very different economics will be accounted for the same. In many cases the proposed rule will make a lease appear the same or worse than the accounting for a purchased asset financed by debt. More will be capitalized than had been thought with estimating the lease term, renewal payments and contingent rents in the capitalization calculation. The capitalization calculation will be complex. The proposed P&L treatment is complex. Complex deferred tax accounting will be required as the P&L treatment will not match the tax treatment. The requirement for continued adjusting for the estimates including contingent rents will be a burden. The likely cash flow statement presentation will not reflect economic effects of a right-of-use lease.
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Recommended Action Comment to the FASB/IASB on the Lease Accounting Discussion Paper.